Related

NEW DELHI: India's economy, which came dangerously close to being given a 'junk status' last year, may have averted a sovereign ratings downgrade for now but is yet to return to a credible and sustainable growth path.

Plagued with a persistently above-comfort level inflation and decade-low growth rate, the country faces yet another test with the mandate of upcoming elections being viewed as a key indicator of economic growth prospects.

While opinion polls and markets are largely favouring a Narendra Modi-led NDA government to rescue the economy from the rut of 'stagflation', major ratings agencies are of the view that a decisive, rather than fractured mandate would bode well for the country as a whole.

S&P has said that the direction and pace of policy reforms, more than which political party takes control, can affect the ratings on the sovereign. Recently, ratings agency Fitch affirmed stable outlook on India's sovereign credit rating due to its higher growth than peers in the same BBB- bracket but said the country's economy had lost dynamism in recent years.

With S&P and Fitch, looking at India's elections and economic fundamentals for a direction on future sovereign ratings outlook, we take a look at the key factors that are worrying the two major ratings agencies:

1) Political uncertainty: Despite Finance Minister P Chidambaram having effectively dispelled the perception of 'policy paralysis', ratings agencies feel that the new government's pace of implementing reforms would decide the course of growth.

"We believe that the current political landscape in India suggests that no single party could win an outright majority," said Standard & Poor's sovereign credit analyst Kim Eng Tan. "An important factor is how fragmented the government will be. The more parties involved in the next coalition government, the more likely policies will be incoherent and less supportive of credit attributes."

"The elections and subsequent policy actions could decide if the sovereign rating remains investment grade (unsolicited ratings: BBB-/Negative/A-3)," said S&P.

"This can lay the foundation for India's return to a stronger and healthier growth phase in the medium term. Conversely, a fragile government could further delay critical reforms as decision-making gets hampered, curbing revival in the investment cycle and derailing growth."

Ratings agency Fitch expects the economy to expand 5.5% in the current fiscal and 6% in 2015-16, but added that that "the course of the Indian economy is uncertain" because of the political uncertainty.

"A policy push that includes structural and governance reforms, fiscal consolidation and efforts to rein in inflationary pressures would likely require a coherent coalition with a strong electoral mandate," said Fitch.

2) Pace of Policy reforms: The will and decisiveness in carrying through reform measures to get India back on the track for high economic growth will play a big role in global ratings agencies' perception on India's investment potential.

"The new government's policy directions will set the medium-term growth expectations and long-term structural factors for the economy. In our opinion, structural reforms are essential for India to return to healthier economic growth of above 6% on a sustainable basis and stimulate investments," said S&P.

According to Fitch, "Once the next coalition starts implementing its economic policies, it will become clearer whether the economy can return to a higher sustainable growth path or whether it remains stuck at current levels."

"Fitch expects a gradual pick-up in investment in its baseline scenario once the election uncertainty dissipates," according the agency's statement. "Clearance to some 300 projects by cabinet committee on investment would facilitate investment. Some of these projects may have now become unviable or could still face difficulty at state level," it said.

3) Banks & asset quality: According to S&P, "infrastructure, power, metals and mining, and petroleum sectors are more exposed to risks from development in government policies affecting corporate performance and banks' asset quality and capitalization needs."

S&P in its report titled "The New Government's Reform Policies Will Be Critical To The Credit Profile Of Indian Corporates And Banks," has said, "If we revise our sovereign outlook to stable, those negative outlooks on banks and corporate entities, which reflect the sovereign outlook, could also be revised to stable. Ratings on government-related entities (GREs), companies rated above the sovereign, and banks that are capped at the sovereign rating level or benefiting from uplift due to government support will likely be downgraded, if we lower the sovereign rating.

Incidentally, S&P is not alone in raising concerns over the Indian banking system. Last week, International Monetary Fund (IMF) warned that Indian banks don't have enough of a buffer to absorb unanticipated losses, and may have to dip into capital if credit quality deteriorates.

In its global Global Financial Stability Report (GFSR), the IMF said Indian banks have not set aside enough money from profits to cover bad assets compared with others.

"Relative to regional peers, loan loss provisioning appears low in Hungary, India, Indonesia, Malaysia, and South Africa, suggesting that any potential credit quality deterioration may need to be absorbed by equity capital," the report said.

4) Deviation from fiscal consolidation path: Fitch feels that going ahead, fiscal consolidation would be the key driver of ratings. "The combined centre and state fiscal deficit of 7.3% of GDP and gross government debt of 64.7% of GDP are well above BBB- category medians," said Fitch.

The central government met its fiscal deficit target of 4.8% of GDP 'through substantial one-off measures, such as special dividends by state companies, and deferral of bill payments and capital expenditure' raising questions about the feasibility of a fiscal consolidation process going ahead, according to the statement.

"Credibility of the government's fiscal policy would be strengthened through the implementation of a clear strategy to reach the Fiscal Responsibility and Budget Management Act's consolidation path towards a general government deficit of 3% of GDP by FY17," according to Fitch.

5) Inflation: India's inflation is still high compared to its peers and Fitch backs RBI's determination to control price rise.

"Clarity on potentially a new monetary policy framework would likely contribute to lower inflation expectations, subsequently feeding through to lower actual inflation levels. Nonetheless, some structural factors driving inflation, including inefficiencies in food distribution, are in the realm of the government rather than the RBI," according to Fitch.

India's future inflation trajectory is also a concern for RBI. RBI has said that there are risks to the central forecast of 8% CPI inflation by January 2015. "This risk stems from a less-than-normal monsoon due to possible el nino effects; uncertainty on the setting of minimum support prices for agricultural commodities and the setting of other administered prices, especially of fuel, fertiliser and electricity; the outlook for fiscal policy; geo-political developments and their impact on international commodity prices," the bank has said.